Utilities definitely have been one of the market’s most downtrodden sectors of late. The Utilities Select Sector SPDR (NYSE:XLU) — the largest ETF (by assets) dedicated to utilities — has shed 2.4% in the past three months and 3% in the past six. Meanwhile, the SPDR S&P 500 ETF (NYSE:SPY) is up 3.3% and 9.7% in those respective time frames.
But that doesn’t mean there isn’t opportunity in the sector. Two utility stocks in particular stand out — one for its attractive value, and one for its steady performance:
My first selection is America’s largest utility, Exelon (NYSE:EXC). After the company reported disappointing third-quarter profits on Nov. 1, 2012, CEO Christopher Crane said Exelon would consider cutting its dividend if power prices didn’t increase in the near future. Exelon’s stock already had lost 17% between Jan. 1 and Crane’s announcement; EXC finished the year down more than 30% to plumb its worst levels since 2004.
Clearly, investors aren’t amused about a potential cut to its healthy $2.10 annual payout. On the Jan. 9 edition of Mad Money, Jim Cramer proclaimed, “I own utilities for dividends. If these guys aren’t giving me one, then sell, sell, sell.”
The current situation isn’t unique to Exelon; however, you can understand Cramer’s sentiment. Retirees need to know that the income they depend on is going to be there in the future. So, if you’re in that boat, you don’t want to own EXC at present.
But … if you’re interested in capital appreciation over dividends, Exelon is a different story.
While there are plenty of Exelon detractors out there, its clean energy assets make it very attractive long-term. Approximately 62% of its power comes from nuclear, solar and wind assets, with just 6% from coal. Its nuclear power fleet is the third largest in the world, providing a dependable and efficient power source.
Nuclear provides 19% of the nation’s energy, but only requires 9% of the capacity; compare that to natural gas, which provides 25% of the nation’s energy but requires 41% of the capacity. With nearly zero emissions, nuclear not only is more efficient, it’s also far cleaner than either coal or natural gas. A carbon tax eventually will be introduced; when it is, companies focused on clean energy will win the day. Until then, Exelon shareholders should hope for higher natural gas prices in 2013, which will deliver greater profits in nuclear power.
Something rarely discussed because of the speculation over Exelon’s potential dividend cut are the cost savings (estimated at $625 million) from its merger with Constellation Energy. This past November, EXC received the 2012 Platts Global Energy Award for successfully completing this strategic deal in a time of uncertainty. I don’t believe Exelon’s current valuation factors in those savings.
Ultimately, my argument for owning Exelon is a simple one. Most of the largest diversified utilities have a 52-week high-low spread of only a few dollars, limiting the potential upside from owning the stock. Exelon, being more volatile, has a current high-low spread of $12, providing investors with far more potential on the upside. Do I think the downside risk at this point is limited? One can never know for sure, but investors certainly have priced in the effect of a future dividend cut.
The rest is up to Mr. Market.
My second pick is a company I recently got to know while exploring investment opportunities in wind energy. NextEra Energy (NYSE:NEE) has 83 wind projects in the U.S. and Canada with a combined power capacity of 10,000 megawatts. NEE is spending $4 billion on wind energy over the next four years, and it has far more capacity than any other utility — including Exelon.
Although wind energy represents more than 50% of the generating capacity of NextEra’s competitive energy subsidiary, natural gas, nuclear, oil, hydro and solar also make a contribution. All told, approximately 95% of its electricity is derived from clean energy sources. Most importantly, its energy resources segment generated a net profit margin of 17.6% in the first nine months compared to 12.7% for Florida Power & Light, its bigger regulated business.
Although NextEra isn’t cheap at the moment, it’s one of the steadiest performers over the past decade, with just one year (2008) sporting a negative total return. In addition, NEE’s annual dividend of $2.40 (3.4% yield) is not in jeopardy of being cut.
Having said that, if debt makes you nervous, it has approximately $25 billion, which is considerably higher than Exelon’s.
If I had $10,000 to invest here, I’d probably put $7,000 in NextEra and $3,000 in Exelon. While I think the value play is very tempting, NextEra is the stronger company.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.